When choosing a mortgage product, one of the most important choices to secure your best outcome is what interest rate type is best for you? Both have their pros and cons. But for most, as you will see, there is a clear winner.
Most brokers, and me included, typically showcase variable rate mortgages as the best option. This only varies if a particular need of yours or a unique situation makes fixed the way to go.
Variable-rate mortgages are tied to the Prime Rate. As the key policy rate changes so will the variable rate. Fixed rates are not tied to this policy. They are positively related to bond yields. As bond values go up, so will fixed rates.
Over the past 50 years, variable has typically been lower than fixed. Although the chart below doesn’t go back this far, you can see how the past 2 decades have been.
source: Ratehub.ca
Fixed-Rate Mortgages
An interest rate set for the duration of the term (can be 1-10 years, with 5 years being the most common) where the interest rate and payments are fixed.
Whether the rates change around you, you are locked into this rate. That may provide peace of mind, but if fixed is higher than variable, is that premium really worth it? Sure, if you managed to get a super low rate, it may be just what you should do. For some kinds of employment or people who want that steady and consistent payment, fixed can also be beneficial. However, there is a smart way to get the benefits of that peace of mind and grow your wealth at the same time.
How?
Leverage a variable-rate mortgage and all its benefits - artificially make your payments fixed. Let me explain. This requires that variable is less than fixed to work. Assume your variable-rate mortgage costs you $2000/m and the fixed-rate mortgage would cost you $2500/m. Pay the variable-rate mortgage and then save (pay yourself) the other $500 every month. With that extra savings, while maintaining a consistent cash outlay (the same as you would have with a fixed-rate mortgage), invest it and compound the effect of that and see how much better off you will be. You will be happy.
Variable-Rate Mortgages
The Bank of Canada Prime Lending Rate is the annual interest rate that Canada’s major banks and financial institutions, use to set their own interest rates for variable rate loans, including mortgages. When the Bank of Canada’s Prime Lending Rate changes, the Prime Rate adjusts accordingly by most banks. So, the interest rate you will pay as a mortgage holder will change, but your payments may or may not depending on whether your variable mortgage is a variable rate mortgage or an adjusted rate mortgage.
Variable Rate Mortgages - When the Prime Rate changes, monthly payments will always stay the same, but the pace at which you are paying down your mortgage will change. (i.e., If the Prime Rate increases, the monthly payment will stay the same, but it will take you longer to pay off your mortgage).
Adjustable Rate Mortgages - When the Prime Rate changes, your monthly payment amount changes too. At the same time, the pace at which you are paying down your mortgage will remain unchanged. (i.e., If the Prime Rate increases, then your monthly payment will also increase, so you will still pay off your mortgage in the same amount of time).
Note: Check the fine print or your mortgage commitment to learn which one you get with that rate and lender to ensure it meets you needs.
Historically, from a pure rate perspective and as you see in the chart above, variable rates have been lower than fixed. Sure, the past may not predict the future, but have been proven a good choice. At time of writing, for high-ratio purchases, fixed-rates are around 2.59% and an variable-rate (adjustable) starting at 1.20% on a 5-year term. This makes variable-rate mortgages typically less costly allowing you to save more.
They are also more flexible. Your life is bound to change, even when its unexpected, and when it does, variable rate mortgage will make things easier.
Penalties!
Did I mention the penalties? What if you break your mortgage term early because you wanted to sell your home, upgrade or even refinance to consolidate debt or buy and investment property? There are so many reasons that can come up. Even unexpected ones. The way a penalty is calculated when you break your mortgage differs from lender to lender, but typically, fixed-rate mortgages have much higher penalties due to that calculation. I had a client that would have cost them over $100k to break their fixed-rate mortgage. Although your penalty might not be that high, it is almost always higher for fixed than variable. When you break a variable mortgage, you only pay a 3-month interest penalty. When you break a fixed-rate mortgage, you pay the interest rate differential (IRD) multiplied by the number of months left in the mortgage. That can be huge.
There are always various things to consider when figuring out what is best for you, based on your unique situation and current market conditions. It is best to give me a call and share more about your situation so I can help you do better. It’s what I do!
